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Economic Crisis/Ecological Crisis, Capitalism/Post-Capitalism
Cortona, Italy
September 10, 2009
I. Introduction
In 2003 Robert Lucas, professor at the University of Chicago and winner of the 1995 Nobel Memorial Prize in Economics gave the presidential address at the annual meeting of the American Economics Association. After explaining that macroeconomics began as an intellectual response to the Great Depression, he declared that it was time for the field to move on: "the central problem of depression prevention," he declared, "has, for all practical purposes, been solved, and has, in fact, been solved for many decades."[1]
Paul Krugman, our latest Nobel laureate in economics, points out, in his current best seller, The Return of Depression Economics and the Crisis of 2008, that Lucas was hardly alone in holding this view. Indeed, it has been the prevailing wisdom of the profession for nearly half a century. As you may surmise from the title of his book, Krugman dissents. "Looking back from only a few years," he writes, "with much of the world in the throes of a financial and economic crisis all too reminiscent of the 1930s, these optimistic pronouncements sound almost incredibly smug." [2]
"All too reminiscent of the 1930s." Let us recall for a moment that momentous decade, which began with a bang and then got really ugly. As John Kenneth Galbraith remarked, "The singular feature of the Great Crash of 1929 was that the worst continued to worsen."[3] The world was transformed.
For one thing, the Great Crash seemed to confirm Marx's theoretical conclusion that capitalism is inherently prone to economic crises, and that these would tend to worsen over time. This confirmation invigorated the international communist movement, which developed active parties in virtually every country in the world.
The economic crisis also invigorated the fascist movement, whose virulent anti-communism garnered the support of wealthy, threatened backers throughout Europe, and gave us, not only a vicious anti-semitism that resulted in the Holocaust, but World War II as well.
The Great Depression also set the stage for a new form of capitalism, eventually called "welfare-state capitalism, or "social democracy," the form thought to be impervious to financial catastrophe.
II. The Current Economic Crisis
We're in an economic crisis. Why? Let me focus on the United States, my country, where all the trouble began. Let's begin with the standard story: the subprime mortgage debacle has caused a general liquidity crisis, which, in turn, has provoked a severe recession
But what is a "liquidity crisis"? Let us back up for a moment. As everyone knows, the stock market collapse on that notorious "Black Tuesday," October 29, 1929 ushered in the Great Depression. But how could a collapse of the stock market--the devaluation of pieces of paper held mainly by the rich--lead to an economic collapse that lasted a decade? Remember, this was not a natural disaster. We are not talking here of war or pestilence or drought, but of pieces of paper suddenly losing value. How could this "accounting fact" lead to massive misery?
The answer lies with banks--where finance meets the "real" economy. A stock market crash, in and of itself, need not cause much damage. Witness the Crash of 1987, which saw the U.S. stock market plunge 23% on October 19--nearly twice the 12% drop on Black Tuesday. The real economy barely blinked this time. The Federal Reserve rushed cash to the banks. Within a couple of months the stock market itself had recovered.
It is when banks get in trouble that the real economy is affected. Businesses need regular access to credit, since, typically, labor and raw materials must be purchased before the finished product is sold. Consumers, too, need access to credit, particularly for expensive, durable items like homes and cars. If access to credit dries up, spending contracts, production contracts, workers are laid off, effective demand contracts further--the familiar downward recessionary spiral.
Back to the present: the standard story. A "housing bubble" led to a proliferation of subprime mortgage lending. (With house prices going up, where's the risk? Who cares if the borrower can't afford the mortgage? If the borrower defaults, the house can be resold--at an even higher price.) These subprime mortgages, along with most other home mortgages, were sold to investment banks, which cut them into pieces, repackaged them as "mortgage backed securities," and sold them to eager investors everywhere. (A "mortgage backed security" is essentially a contract to receive portions of the repayments of many loans.) These mortgage-backed securities were highly liquid, i.e., easy to sell on short notice if the buyer needed cash--at least they were before the crisis.
When housing prices stopped rising, and when "teaser" interest rates gave way to market rates, homeowners began to default in large numbers, especially those who had insufficient income in the first place, those to whom the "subprime" mortgages had been granted. Suddenly no one could tell what mortgage-backed securities were worth, since it was virtually impossible to ascertain, for a given security, how much income it could be expected to generate, given that many of its many-thousand pieces (how many?) were in or near default. So the markets for these securities, and indeed for most other "collateralized debt obligations," froze. There were no buyers at all for these particular pieces of paper.
Okay, so what? Investors can't sell certain pieces of paper. So what? Now we get to the banks. Commercial banks, which make loans to individuals and businesses, hold many of these "pieces of paper." When money is deposited in a bank, as you know, it is not simply stashed in a vault. A bit of it is (as is required by law), but most of it is either loaned out to customers or used to purchase securities. (After all, it makes no sense for a bank to keep idle cash on hand, when it could be "put to work" making more money.) If extra cash is needed to make new loans or to return to depositors who want to take their money out, the banks can simply sell their securities to raise the cash. Or at least they could before the crisis. Suddenly they couldn't. (They still can't.) No one will buy these "toxic" securities--unless the taxpayers agree to assume the risk. Now we have a "liquidity crisis." (I'm oversimplifying some, but this is the basic picture.)
But we know how to resolve a liquidity crisis, don't we? Isn't that what Robert Lucas was telling us? Here's Krugman's again:
Most economists, to the extent that they think about the subject at all, regard the Great Depression of the 1930s as a gratuitous, unnecessary tragedy. If only the Herbert Hoover hadn't tried to balance the budget in the face of an economic slump, if only the Federal Reserve hadn't defended the gold standard . . . if only officials had rushed cash to threatened banks, . . . then the stock market crash would have led to only a garden variety recession, soon forgotten. And since economists and policymakers have learned their lesson . . . nothing like the Great Depression can ever happen again.[4]
But consider: We're not trying to balance the budget, to put it mildly. We're not defending the gold standard--or even the dollar. We have been rushing cash to threatened banks. So, from the point of view of current orthodoxy, we are doing everything right. Yet the unemployment rate continues to rise. To be sure, the panic seems to have subsided, and the U.S. stock market has rebounded a bit (to about where it was in 1998), but as Mortimer Zuckerman, Editor-in-Chief of U.S. News and World Reports wrote eight weeks ago, in an article entitled, "Nine Reasons the Economy is Not Getting Better":
The appropriate metaphor is not the green shoots of new growth. A better image is to look at the true total of jobless people as a prudent navigator looks at an iceberg. What we see on the surface is disconcerting enough. . . . The job losses are now equal to the net job gains over the previous nine years, making this the only recession since the Great Depression to wipe out all employment growth from the previous business cycle.[5]
Beneath the surface, things look even worse--people not counted as unemployed who are, people working part time who want full-time work, people taking unpaid leaves, little prospect of job creation, etc. As a result, "we could face a very low upswing in terms of the creation of new jobs, and we may be facing a much higher rate of joblessnesss on an ungoing basis."[6]
When we look globally, the situation appears worse still. In an article published in April, updated in June, economists Barry Eichengreen (of the University of California, Berkeley) and Kevin O'Rourke (Trinity College, Dublin) compare the current crisis to the Great Depression, looking at both globally. They compare both periods with respect to three variables: world industrial output, world stock markets and volume of world trade. The article title states their conclusion: "It's a Depression Alright."
Globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports, or equity valuations. Focusing on the U.S. causes one to minimize this alarming fact. The "Great Recession" label may turn out to be too optimistic. This is a Depression-sized event.[7]
So--why aren't the standard remedies having a more profound effect? It's time for a more Marxian-Keynesian analysis. From this perspective, the fundamental problem is not the housing bubble, or subprime lending, nor is it Wall Street greed nor excessive speculation nor even deficient regulation. These factors played a role, but the real cause lies deeper.
Let's begin with Marx's basic insight: The seemingly irrational "overproduction" crises of capitalism are rooted in the defining institution of capitalism: wage labor. The commodification of labor gives rise, over time, to a contradiction. Since labor (technically "labor power") is a cost of production, capitalists strive to keep its price (the wage rate) low. At the same time capitalists need to sell their products, so they need wages to be high. Hence an ever-present crisis tendency: if workers don't have the money to buy what is produced, production is cut back, workers are laid off, demand drops further . . . the downward spiral.
"But wait!" you might say, "Not so fast. Workers aren't the only ones that purchase goods. So do capitalists. If the gap between what is produced and what workers can buy is filled by the purchases of capitalists, recession can be avoided."
We are touching here on a key difference between Marx's analysis and that of Keynes. Whereas Marx focuses on the constraints to workers' consumption, Keynes focuses on the behavior of the capitalists. Let's follow the Keynesian trail at this point.
What do capitalists buy? Consumer goods, to be sure, but not nearly enough to close the gap. It is a fundamental feature of a capitalist society that capitalists do not simply consume the surplus that workers have created. Feudal lords might have routinely consumed all the surplus their serfs produced, but what gives capitalism is fundamental dynamic is the fact that capitalists routinely reinvest a portion of their profits, so that they can reap even greater rewards in the future.
But what does "reinvestment" mean in real, material terms? Well, it means purchasing capital goods, not consumer goods, i.e., the extra building space, machinery and raw materials that will be utilized during the next production period to produce more than was produced during the preceding period. So long as the capitalists keep reinvesting, the economy can keep growing, can remain healthy, can avoid recession. But if the capitalists don't invest, then the economy slumps.
Moreover, as Keynes emphasized, the market's invisible hand will not automatically turn things around. To the contrary, market incentives often make matters worse: if the economy begins to slump, prices drop, companies go bankrupt, workers are laid off, demand drops further, etc. The downward spiral has no built-in countertendencies. An external event, or series of events, can sometimes turn things around, something that inspires investors to begin investing again, but there is no guarantee that such events will occur. Therefore, governments must intervene when a recession threatens. If government action isn't swift and substantial, a recession can turn into to a full-blown depression.
What can governments do? The received wisdom of the past three decades has focused on monetary policy: keep the money supply growing so that credit for business expansion is always available. When a recession threatens, cut interest rates, so as to make business and consumer borrowing (and hence business and consumer spending) more attractive, and provide structurally-sound banks with liquidity (cash) in times of trouble so they can keep lending.
This is suitably Keynesian, but for Keynes monetary policy alone may not be enough. Making money available to banks or to consumes doesn't guarantee it will be loaned out or spent. Monetary policy may amount to pushing on a string. Keynes--and his more radical followers--also pushed for something else, namely fiscal policy: large-scale government employment and purchases, the costs of which should be allowed to exceed tax revenues when recessions threaten. Governments should provide the stimulus of public employment and purchases when private employment and purchases fall off. This, of course, is a significant part of the Obama stimulus package. It is also Paul Krugman's recommendation--although he thinks the package should be larger and more aggressive than it is.[8]
But notice, neither monetary nor fiscal policy addresses Marx's insight. What if wages are too low? We should remember that the post-War period witnessed a quasi-political "class compromise" that permitted labor to organize and bargain collectively, so that workers could share in the productivity gains. For several decades following WWII, this development, combined with Keynesian monetary and fiscal policies, worked. It produced what is sometimes referred to as capitalism's "Golden Age." Here's Krugman's description of the United States during this period: